Asia Pacific Economic Outlook, July 2014: Weekend Reading

This edition of the Asia Pacific Economic Outlook gives a near-term perspective for China, India, Indonesia and the Philippines. New governments in India and Indonesia have their work cut out. China wants to balance economic growth with reforms, while the Philippines’ strong economic momentum continues this year.

China: Balancing Growth and Reform. China’s economy continues to show signs of weakness, although there are also signs of stabilization at a relatively modest level of growth. This is creating a dilemma for the government. On the one hand, it wants to maintain economic growth at a level that avoids social disruption. In the short term, this entails boosting credit market activity. On the other hand, the government wants to implement long-term reforms aimed at creating sustainable growth that does not rely on excessive credit growth. That means restraining the growth of credit. What should it do? Currently the government is doing a little of both.

First, in order to maintain growth, the government is loosening the reins on banks in order to stimulate more lending by banks to the private sector. China’s banking regulator has said that it will, once again, reduce the amount of reserves that some banks are required to hold with the central bank.¹ This would be the third reduction in the required reserve ratio in the past three months. The idea is to stimulate more lending to small businesses and first-time home buyers at a time when the economy is slowing more than anticipated. This action is meant to boost credit market activity in general. Yet it follows other measures designed to rein in credit market activity. Thus this measure is meant to boost formal bank lending, while the previous measures were meant to cut off-balance-sheet, or shadow banking, activity.

On the other hand, the World Bank recently criticized China’s current policy of boosting credit as detrimental to reform. It said that boosting credit market activity “may perpetuate China’s traditional growth model that relies on government-led investment fueled by credit expansion.” The World Bank said that “a policy focus on meeting growth targets could distract from pushing through the structural reforms intended to put long-term growth on a more stable footing. Delays in implementing coherent reforms could perpetuate resource misallocation, undermine the health of the banking system, threaten the debt sustainability of local governments, and increase the fiscal costs of reform.”² Meanwhile President Xi Jinping said that fiscal and other reforms are urgently needed, but they must be carefully planned. He urged action but gave little detail. He alluded to the political difficulties of implementing reform when he said that reform involves “difficult adjustment of interests.”³

India: A “Modi-fied” Government. The general election that concluded on May 16, 2014, turned out to be phenomenal. This election recorded the highest-ever voter turnout (551.3 million) and the highest-ever voter participation (66.4%), marking it as the largest democratic election in the world’s history.⁴ It was also the most expensive in the history of independent India. The election outcome was surprising to many investors and civilians, who had expected a coalition government, which has become the norm in India for the last three decades. The Bharatiya Janata Party (BJP) emerged as the single largest party to get a majority in the Lok Sabha (lower house), and the first to get such a mandate since 1984. Narendra Modi, who led the party during the election and is considered to be the biggest reason for the historic won, has been sworn in as India’s prime minister.

The single-party majority has set the foundation for a stable central government for the next five years. Political stability has significantly reduced downside risks to the economy. This has also raised hopes for both domestic and international investors, who are frustrated by policy inaction, slow growth and inflation.

While winning the election with the largest mandate was an uphill task for the BJP this election, challenges that lie ahead for the new government will be equally big and will require adept leadership and economic management. For two consecutive years, the nation has endured growth of less than 5% and a loss of consumer and investor confidence. Those who voted for the BJP hoping for improved governance will now demand results.

Industrialists from different sectors have voiced their demands, especially around substantial reforms and clarity around policy making. Transparent and business-friendly tax policies and regulations, interest rate rationalization, infrastructure development, transparency and accountability in governance and, last but not least, effective policy implementation are the core demands from the business fraternity. These parameters will decide the ease of doing business in India, which, according to the World Economic Forum, has a poor ranking relative to other countries.⁵

The government has taken some initial measures to improve governance, check fiscal balance and inflation, and increase business investments in the economy. However, policy changes isn’t going to be easy in the face of current political roadblocks and economic challenges.

Indonesia: Challenges Before a New Government. Indonesia, the world third–largest democracy and Asia’s fourth-largest economy, goes to the polls in July to elect a new president. Voters, especially the youth, will be eager to exercise their franchise and thereby chart the future of an economy that has the advantage of favorable demographics, large natural resources and strategic location in Asia. The new government has its task cut out. The economy has slowed, with GDP growth falling to 5.2% year over year in Q1 2014 from 5.7% in Q4 2013. Also, concerns regarding inflation, the Indonesian rupiah and the current account have not gone away entirely despite commendable central bank action. To prop up medium- to long-term growth, the government will have to kick-start economic reforms amid a fragmented legislature, tackle corruption, upgrade infrastructure and invest in human capital. After all, at stake is the future of about 250 million people.

The dip in GDP growth in Q1 2014 was primarily due to a 0.8% decline in real exports, which in turn was the result of a sharp decline in exports of crude oil and related products. Worryingly, the pressure on exports is not likely to ease soon given restrictions on key commodity exports such as palm oil, nickel, copper and coal. The measures include a ban on exports of raw mineral ores, restrictions on foreign investments in mining, hikes in export tariffs and domestic quotas.

Slowing commodity prices in 2014 have not helped nominal export values either. For example, coal prices have fallen 15%, and palm oil prices are down 8%. In such a scenario, investments in mineral ore processing—the primary aim of the ban on raw ore exports—are not likely to materialize. Also adding to commodity export woes is slowing growth in China, a key export market. No wonder then that Bank Indonesia (BI) slashed its total exports growth forecast for 2014 to a mere 1.5%–1.9% from an earlier figure of 8.1%–8.5%.

Philippines: The Good Times Continue. In 2013, the Philippines’ economy grew 7.2%, the second highest pace of growth in Asia after China. The momentum has continued into this year, with personal consumption and investments set to remain strong. Buoyed by economic prospects, foreign investors who had moved away from emerging economies in 2013 have started flocking back to the country, thereby strengthening equity markets and the Philippine peso. Then in May came a sovereign rating upgrade by Standard & Poor’s (S&P), pretty much summing up the country’s economic fortunes.⁶

In May, S&P raised its sovereign rating for the Philippines by one notch to BBB with “stable” outlook. The rating major focused on a strong current account (3.5% of GDP in 2013), stable government finances (budget deficit at 1.4% of GDP and gross government debt at 49% of GDP) and positive growth prospects. S&P’s latest move comes about a year after it and other rating majors had upgraded the Philippines to investment grade. Not surprisingly, the rating upgrade has buoyed markets, already on a strong upward streak this year due to positive economic data.

Global investors, who had pulled out of emerging economies in 2013 due to uncertainty over the U.S. Federal Reserve’s (Fed’s) quantitative easing program, appear to be flocking back to the Philippines. They have bought shares worth about $959 million since December 2013.⁷ This has aided equity markets; the Philippines Stock Exchange Index has gained about 15% this year. In the coming months, some correction in equities is expected due to current high valuations (about 21 times reported earnings).⁸ However, it is likely to be only a minor blip in a broad upward trend.

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